Saturday, February 24, 2007

The Bear Case-Part 1

Every bull market generally starts on the basis of solid economic reasons. The reasons could be the relative undervaluation of assets or an increase in the expected future returns. However, as the bull market matures, it gets divorced from the economic reasons that started the bull market. I have personally witnessed several of these bull markets and their degeneration into manias in my life in different parts of the world at different times during last 15 or so years. The most recent one was the housing bubble mania down in the US and the one prior to that was the NASDAQ bubble in 2000.
Once the bull market enters the bubble phase, the same bull market story is sold to the masses and is given as the primary reason for asset price escalation.
The Alberta Real Estate bubble is no different from any of the prior manias we have seen in the past. The same arguments appear here-it's different here, we have a solid story (oil sands, strong economy etc) and other factors as mentioned in my previous post.
Alberta real estate market was in a healthy bull run till around 2005 spring after which all hell broke loose. I personally know of two long time investors who sold at about that time. One was an apartment building complex in Edmonton that was sold for roughly twice the amount it was bought for seven years ago (1997).

Take a look at this listing. Two years ago you could buy a detached starter SFH for around $175,000 in a good part of Edmonton. Now, you'll be lucky to even get a studio for that much!

The question really is-what has changed in the last two years. Why have most of the SFHs more than doubled in price? I do know the simplistic answer-it's the demand and supply. But if only it were that simple. Back in the heady days of Nasdaq bubble, I distinctly recall the day Palm made its IPO appearance. That day the market capitalization of Palm was more than the market captialization of 3Com, the company that actually owned most of Palm! And we do know what happened to Palm a few months after that.
Last year Warren Buffet mentioned a similar disconnect when he mentioned that the sum of land value and the improvement value of homes was way less than the amount for which homes were selling for in the US. The reality is that in a mania the fundamentals matter no more. It's greed and fear. Fear of being priced out forever. Rampant greed of speculators who think that they have become the next investing genius because of their three earlier successful flips. Ultimately, we might want to philosophize this as the 'fallen nature' of humans that expects something by doing nothing.
And if this is the way in which the market has been moving, how can the fundamentals or anyone talking of fundamentals be respected.
I've a lot more to say on this and will continue in my next post.
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